Avoiding the belly of the bond curve
The global economic acceleration phase does not appear to be as robust as in previous cycles, so Christine Horoyski expects the transition to tighter monetary policy and higher interest rates to be longer than some might think.
As a result, the head of fixed income at Toronto-based Aurion Capital Management doesn’t anticipate a sharp or rapid acceleration in bond yields.
“These boom-bust cycles may be smoothing, so we may be in this phase of the recovery for several years, rather than the classic four-year boom/bust cycle,” Horoyski said.
She noted that risk has been rewarded, with equities outperforming bonds, credit outperforming government bonds, P/E multiples rising in anticipation of stronger growth, and longer-term bond yields climbing in anticipation of higher growth and inflation.
Horoyski, who runs the Aurion Income Opportunities Fund and the Dynamic Aurion Total Return Bond Fund, also pointed out that the big sell-off in long-term bond yields has now occurred, and she is becoming much more focused on the shape of the yield curve as opposed to hedging longer-term interest rate risk.
The fund’s position has shifted toward a barbell approach: some exposure to longer-dated bonds balanced with an overweight in short-term, floating-rate notes.
“In a rising rate environment, as the yield curve flattens, shorter-term yields rise faster than longer-term yields,” Horoyski said. “The most vulnerable part of the bond market tends to be the belly, the five-to-10year part of the curve.”
The manager has been upgrading the quality of the fund’s credit exposure as the excess returns paid for risk in the past have been reduced. Focusing on the higher-quality investment grade space also provides additional liquidity.
Horoyski has also been significantly increasing the portfolio’s foreign content, which now stands at 30%, with 10% of that in Australia and modest exposure to Latin American countries such as Chile and Mexico, as they offer higher yields and only a modest step down in credit quality versus the corporate space.